The Federal Reserve on Wednesday took its first step toward withdrawing support for the American economy, saying that it would begin to wind down a stimulus program that’s been in place since early in the pandemic as the economy heals and prices climb at an uncomfortably rapid pace.
Although inflation has risen this past year, central bank policymakers are more cautious about the issue. This is despite booming consumer demand and supply snarls. Officials still expect cost increases will fade quickly, but it is not clear when that will happen.
Fed officials want to be prepared for any outcome at a time when the economy’s trajectory is marked by grave uncertainty. They are not sure when prices will begin to calm down, to what extent the labor market will recover the millions of jobs still missing after last year’s economic slump, or when they will begin to raise interest rates — which remain at rock-bottom to keep borrowing and spending cheap and easy.
So the central bank’s decision to dial back its other policy tool, large-scale bond purchases that keep money flowing through financial markets, was meant to give the Fed flexibility it might need to react to a shifting situation. Officials laid out Wednesday a plan to reduce their $120 billion monthly Treasury bond and mortgage-backed securities purchases by $15 billion per month, beginning in November. The purchases will lower long-term interest rates, and encourage investors to make investments that would stimulate growth.
Assuming that pace holds, the bond buying would stop altogether around the time of the central bank’s meeting next June — potentially putting the Fed in a position to lift interest rates by the middle of next year.
The Fed isn’t yet stating that higher rates are imminent, a powerful tool which can quickly slow demand and offset inflation. To allow the labor market to heal, policymakers would prefer to keep them low for a while.
The Wednesday announcement will make them more agile to react to inflation if it remains high into 2022, instead of starting to moderate. Many officials wouldn’t want to raise interest rates while they still buy bonds. This would be a double-edged sword that would allow one tool to stimulate the economy and the other to restrain it.
“We think we can be patient,” Jerome H. Powell, the Fed’s chair, said of the path ahead for interest rates. “If a response is called for, we will not hesitate.”
Congress has given the Fed two jobs: to achieve and maintain stable prices and maximum employment.
These are difficult tasks for 2021. Twenty months into the global coronavirus epidemic, inflation has increased, with prices increasing 4.4 percent from September to now. This is well over the 2 percent average price increase that the Fed has aimed for in the past.
However, the number of people working is far lower than it was before the pandemic. Five million jobs are now missing, compared to February 2020. The shortfall is hard for businesses to understand as they struggle to fill vacant positions across the country. Wages are also rapidly rising, which is a sign of a strong job marketplace.
For now, the Fed believes inflation will decline and that the labor force will be more attractive to workers.
“There’s room for a whole lot of humility here,” Mr. Powell said, explaining that it was hard to assess how quickly the employment rate might recover. “It’s a complicated situation.”
Officials were surprised by the extent to which inflation has risen this year and how long it has lasted. Officials expected some inflation as prices rose after the price of food and air travel rebounded from the pandemic-lockdown lows. However, Fed officials and economists were surprised by the severe supply chain disruptions and continued strong consumer demand.
The Status of U.S. Jobs
The U.S. economy continues to be affected by the pandemic in many ways. It is important to pay attention to the state of the job market, and how it changes as economic recovery progresses.
Officials at the Fed predicted that this inflation surge would recede in their November policy statement. However, they have since lowered their confidence in that prediction. They said previously that factors causing elevated inflation were transitory, but they updated that language on Wednesday to say that the drivers were “expected to be” transitory, acknowledging growing uncertainty.
“Supply and demand imbalances related to the pandemic and the reopening of the economy have contributed to sizable price increases in some sectors,” the statement added.
While the Fed is willing and able to tolerate temporary inflation until the economy recovers after the pandemic, if consumers or businesses start to expect higher prices, it could spell trouble. Businesses will have trouble planning if high and erratic inflation continues. It could also affect wage increases for workers without bargaining power.
“We have to be aware of the risks — particularly now the risk of significantly higher inflation,” Mr. Powell said. “And we have to be in position to address that risk should it create a threat of more-persistent, longer-term inflation.”
Understanding the Supply Chain Crisis
Investors were well prepared for Wednesday’s announcement and took the news that bond buying will slow in stride. The S&P 500 rose 0.7 percent by the end of trading, reaching a new high.
That’s notable because of the market’s tumultuous reaction in 2013, when the Fed hinted that it would soon end a similar program that had been put in place in response to the financial crisis. A repeat of what came to be known as the “taper tantrum” in financial markets appears to have been avoided through the Fed’s ginger communication in recent months.
Mr. Powell said the Fed would be “very transparent” if it should decide to speed or slow the pace of its winding down of the bond purchases, noting that it did not want to surprise markets.
“They’re giving themselves the maximum amount of flexibility,” said Seema Shah, chief strategist at Principal Global Investors, of Wednesday’s statements from the Fed. “In fairness, this is a really uncertain environment, right? And there are things going on which are driving the economy which are really out of the Fed’s control. So they can only try to be responsive.”
Officials have attempted to seperate their plans for higher interest rates from their plan for slower bond purchases. Investors expect rate increases to begin midway through 2022.
The Fed has stated that it wants full employment before increasing borrowing costs to cool down the economy. Mr. Powell made it clear that the job market is still far from reaching that goal. He stated that it was possible, but not certain, for the Fed to reach maximum employment next year.
It could be costly for the Fed to raise interest rates to control inflation before the labor market recovers. Some employees may have retired since the outbreak of the pandemic. However, many of those who are being left behind are still in their prime years of work. They may look for new jobs once child-care issues are resolved.
If the Fed slows down the economy before it can, it could make it harder for workers to get into new jobs. This could leave the economy with less potential and fewer paychecks for families.
“We’re accountable to Congress and the American people for maximum employment and price stability,” Mr. Powell said, noting that the pace of inflation right now is not consistent with price stability, but that the economy is also not at maximum employment.
He called the Fed’s stance a “risk management” approach.
“He acknowledged that there is a lot of uncertainty around the outlook right now,” said Laura Rosner-Warburton, senior economist at MacroPolicy Perspectives. “Policy needs to have flexibility.”
Matt PhillipsContributed reporting
Source: NY Times